Economics is a pretty simple subject. Strong demand leads to rising prices, which in turn sends a signal to the market to increase supply. The additional supply then pushes the price level back down until a new equilibrium is reached. Simple.
Except this doesn't always work. An article in this week's Economist magazine points out that despite strongly rising oil prices, the average output of the large oil companies actually declined by 9% in the third quarter compared to the same period last year.
This inadequate supply response suggests the world is running out of cheaply accessible oil, and that high prices are here to stay.
"The International Energy Agency, an energy watchdog for rich countries, reckons that the expansion plans of the big Western and state-owned oil firms will leave the world 12.5m barrels per day short of requirements in 2015."
"Despite this looming deficit and the glaring price signal, all the big companies except Total produced less oil and gas in the third quarter than they did in the same period last year."
The oil price has backed off in the past few days after the crude oil futures contract nearly hit the psychologically important level of US$100 per barrel. However, with the futures contract currently around US$96 per barrel, it seems only a matter of time before prices break through this level and surge higher.
Bloomberg recently reported BP chief executive Tony Hayward saying, "Every geopolitical event causes a spike in the price, but these spikes only happen because the underlying market is itself tight.
"For the medium term, the era of cheap energy is behind us.''
